Top 7 Reasons Why Global Free Trade Doesn’t (Always) Work

The signs of our economic decay are everywhere.

Over the last 40 years, millions of Americans’ jobs have been offshored, the unemployment rate’s skyrocketed, and income inequality’s risen dramatically—all because of bad trade policies created by stupid politicians and greedy special interests.

The problems are caused by economic globalization.

Here’s why free trade doesn’t (always) work:

1.  Comparative Advantage Doesn’t Always Apply

Global free trade is underpinned by David Ricardo’s theory of comparative advantage.  But, like any theory, it has its limits—it’s domain specific, it only works in certain situations.

David Ricardo, creator of the theory of comparative advantage
David Ricardo (d. 1823) is best remembered for his theory of comparative advantage.

First, Let’s Define Comparative Advantage. What is it?

Basically, it’s the idea that countries should trade stuff they’re relatively good at making for stuff they’re relatively bad at making.

This improves economic efficiency, and therefore makes everyone richer.

It’s a good theory, and it’s true.  The problem is that free-traders always leave out its intrinsic limits.

Limit #1: Ricardo himself realized that his theory wouldn’t work if it were possible to offshore production from one country to another (eg. move a factory from America to China, and then import the stuff from China).  He recognized that this would undermine the country’s economy.

To “fix” this problem, Ricardo argued that:

most men of property [will be] satisfied with a low rate of profits in their own country, rather than seek[ing] a more advantageous employment for their wealth in foreign nations

Essentially, comparative advantage only works in a world where people aren’t greedy (according to the guy who invented comparative advantage).

Go figure.

capital is mobile in a global economy
In today’s economy, capital is incredibly mobile. Shipping is incredibly (almost hilariously) cheap, credit is plentiful, and it’s very easy to relocated entire factories abroad.

Limit #2: Ricardo also employed a more technical defense.  He argued that offshoring was impossible because capital was immobile (ie. you couldn’t move a factory, even if you wanted to).

This was true when he was alive, but not anymore.

Today, capital is incredibly mobile, and it’s very easy and (almost hilariously) cheap to relocate a factory to a developing country.

These two facts, that (i) people are greedy and (ii) capital is mobile, completely debunk the theory of comparative advantage by invalidating its underlying premises—the theory only works in a domestic setting (within a country), where offshoring isn’t a problem.

Ardent free-traders, like Ben Shapiro, have bastardized comparative advantage for their own purposes, and misapplied it to an inapplicable domain.

2.  Trade Doesn’t Cause Economic Growth: Technology Does

Maximizing comparative advantage doesn’t grow the economy in the long term, it just provides a one-time efficiency-boost.

Economies grow when they make more, not when they consume more.

This is why GDP measures output, not consumption—consumption can be temporarily raised by selling your furniture, or buying things with your credit cards, production can’t.  Production (GDP) measures the size of the real economy.

There are only two ways to increase production:

1. Work harder (increase the number of hours worked, increase the population etc.).

2.  Work smarter (improve productivity, so you get more done per hour).

Option (1) provides linear growth, meaning that the harder you work, the bigger the economy will be, on a one for one basis.  This doesn’t really make anyone richer in real terms.

Option (2) allows us to do more with less (make more stuff in the same time).  That’s real (exponential) economic growth.

A good example is Britain’s cloth-weavers during the Industrial Revolution.  The power loom made each weaver 40 times more productive than those on traditional looms.  This let Britain make tons of cheap, high quality cloth.

The standard of living improved dramatically.

Edmund Cartwright's power looms in factory
Edmund Cartwright’s power loom (1785) made British weavers 40 times more productive. The economy grew exponentially.

How do you improve productivity?  Well, you can maximize your comparative advantage.  But like I said, this is a one-off trade.  It doesn’t provide long-term gains.

The only way to improve productivity in the long run is to improve technology.

Better technology (like railroads, light bulbs, automobiles) can greatly (and forever) improve the economy’s productivity.

It’s the only thing separating us from our Neolithic ancestors (economically speaking).

railways increased economic productivity
Railways did more for the economy than international free trade every did (or could). The same goes for refrigerators or light bulbs.

Therefore, a good economic policy will focus on retaining industries that generate technological discoveries.  Instead, America’s offshoring its advanced industries at an alarming pace.

3. Economic Globalization Predicts Absurdities

No one would have believed Isaac Newton if his theory of gravity predicted that apples fell up: a theory is only useful if its predictions match reality.  The same is true in economics.

Comparative advantage is wrong because it predicts absurd results.

Absurdity #1:  Rich Countries Have Specialized Economies

According to comparative advantage, the way to get rich is to specialize.  This is because the more specialized the economy is, the more its comparative advantage is maximized.

In reality, the opposite is true.

Richer countries usually have diverse, not specialized, economies.  This is because businesses, and industries, cluster together.  By doing so they can share supply chains, labor pools, and transportation costs.  Essentially, where you find one thriving industry, you’ll find more.

There’s a reason the term banana republic is synonymous with poverty.

free trade keeps banana republics poor
No matter how specialized you are, it’s hard to get rich when a stiff frost could wipe out your entire livelihood.

Absurdity #2:  The Type Of Output Doesn’t Matter, Only The Degree Of Specialization

According to comparative advantage, the only variable that matters is the degree of specialization.

Theoretically, it doesn’t matter if the country specializes in growing coffee or making semiconductors—what matters is how much comparative advantage is being maximized.

In the real world, there is a very strong statistical correlation between a country’s wealth and the complexity of its exports—what you make matters.  A country building jet engines and semiconductors is going to be richer than one making jerked beef and cornmeal (regardless of how specialized they are at jerking beef).  That’s just how it is.

Compare the exports of the United Kingdom and Kenya, and you’ll get the point.

kenya vs united kingdom exports

Not all industries are of equal value.  Pharmaceuticals is simply more valuable than dairy or corn.

Period.

Specialization via free trade won’t necessarily make a country rich—having the right industries will.  Sometimes, free trade undermines these lucrative industries (by offshoring them to developing countries), and therefore hurts economic growth.

4. Trade Boosts Consumption, Not Necessarily Production

Free trade only makes sense when trading goods for goods (if everyone makes what they’re best at, economic efficiency improves, and more goods are made in total).  However, it doesn’t apply when trading goods (present output) for assets (past output) or debt (future output).

For example: if America trades property and corporate shares for Chinese goods, then it’s possible that global production could fall, until America runs out of accumulated wealth to sell.  In this case, wealth is shuffled around, rather than created.  The same is true of debt.

This is what’s currently happening.

This process is unsustainable: at some point America will run out of stuff to sell.  At that point, we will either need to decrease our consumption (which lowers our standard of living) or increase our domestic output to trade for Chinese goods (why delay what’s inevitable?).

Right now we’re living in a consumption bubble, paid for by selling our inheritance and mortgaging our future.  Eventually we’ll have to pay the piper—everything has a price.

5. The Okun Gap

Factors of production (things like buildings, machines, people) don’t always move seamlessly between industries.

What does that mean?

Pretend America sings a trade deal with Nepal.  As it turns out, the Nepalese are very adept at building jet turbines (for cheap).  In exchange, they buy America’s sirloin steaks.  They love Texas prime.

This situation is bad for America’s jet turbine makers (who go out of business, or relocate to Nepal), but good for our cattle ranchers.

The problem is that all of America’s turbine factories, the machinery, and the technicians and engineers are now unproductive, since capital equipment from the turbine industry can’t be used in ranching (engineers usually make bad cowboys, go figure).

The factories and machines will be scrapped, and the workers will need to find other employment.  This all takes time, and sometimes the capital sits idly for years—even decades.  Just look at all the factories in the Rustbelt that are idle to this day, how much production did we lose?

America's rustbelt & industrial decline was caused by free trade
Abandoned factories dot the landscape in America’s rustbelt. Imagine how much production we’ve lost by letting them remain idle. This undermines the supposed benefits of free trade—they’re not as big as you think.

The disparity between what the economy could produce at full output (if capital was being employed, rather than mothballed or transitioned) and what it is actually producing (apparently more efficiently due to the maximization of comparative advantage) is called the Okun gap.

When this is taken into account, the “gains” free trade brings aren’t as big as we’re led to believe.

 6.  Theories Don’t Always Work In Practice

The best way to grow the economy isn’t always the most efficient way.

In the 1980s the it would have been rational, according to free trade theory, for China to invest heavily in agriculture, to better maximize its comparative advantage in sericulture and rice-growing.

Hong Kong & China benefits from free trade, at America's expense
Hong Kong’s glittering skyline—it wasn’t big rice money that paid for all this.

They didn’t do that.

Instead, they invested in manufacturing (for which they lacked even the most basic infrastructure or skills).  This was inefficient (short term), but beneficial (long term).

The same was true of India’s investments in IT industries, and yet technology has turned into India’s economic bread and butter.  The right kind of short term pain can result in long term gain, and the opposite is also often true—there is no easy money.

Perhaps the most ironic (and best) way to end this section is to revisit David Ricardo’s example, and look at what happened in real life.

England and Portugal actually did trade wine and cloth historically.

In 1703 they signed the Treaty of Methuen, which, among other things, exempted English cloth from Portugal’s import prohibition.

In the following decades, Portugal’s textile industry was destroyed by cheap English imports, and Portugal indeed resorted to exporting wine.

Soon afterwards England:

  1. Gained a textile monopoly in Portugal (they could drive up prices to above-market rates).
  2. Expanded her increasingly-advanced textile industry (which stimulated mechanical and engineering breakthroughs which birthed the Industrial Revolution)
  3.   Used the profits to buy up Portugal’s vineyards, thus securing both industries (cloth was more lucrative than wine).

In the end, this deal helped England industrialize and grow rich—at Portugal’s expense.

This was great for England (China) bad for Portugal (America).

So much for “efficiency”.

7.  There’s More To Good Policy Than “Efficiency”

It’s important to remember that comparative advantage is merely a tool that tells us whether or trade is efficient.  It doesn’t tell us whether its strategically beneficial, or economically sound.

Comparative advantage isn’t an economic policy, any more than “supply and demand” is economic policy.  Lots of people, from Henry Kissinger or Milton Friedman, forgot this.

It may have been efficient to offshore our factories to China (& friends), but was this good policy?  No, America’s lost 10 million jobs in the process—this slows our economic growth and bloats our welfare system, leading to higher taxes and bigger government.

On the other side, China’s economy is as large as ours, and they’re challenging our hegemony in East Asia.  We built ourselves a rival.  This endangers both America and the world.  Why would you want a rival power to catch up to you in economic, and therefore political and military strength?

I think that’s a stupid idea, don’t you?

Strategically, the best option is to sacrifice your own growth, if it sets your rivals back much more.  All we’ve done is trade a small absolute gain for a large relative loss.

Remember, Britain did the same thing to Germany in the 1870-1890s.

It didn’t turn out well for them.

Or us.

The Big Picture: Global Free Trade Failed Us

At the end of the day, free trade isn’t a policy, it’s a tool.  It’s a means to an end.

It also has its limits.

We need to stop misapplying comparative advantage to inapplicable domains.  Free trade is generally effective domestically, but it doesn’t always work on an international level, between asymmetrical trading partners.

If our goal is to create a prosperous society that works for everyone, we need to look beyond the black and white dichotomy created by free-trading ideologues, and realize that reality, and history, doesn’t match our models.

We need a coherent, focused national economic policy, designed to drive growth and spur technological innovation.

This is the key to success.

Select Sources:

Bairoch, Paul. Economics and World History: Myths and Paradoxes. Chicago: University of Chicago Press, 1993.

Bernstein, Willian J. A Splendid Exchange. New York: Grove Press, 2008.

Chambers, J.D. The Workshop of the World: British Economic history from 1820-1880. London, Oxford University Press, 1961.

Lance, Davis E. and Robert E. Gallman. Evolving Financial Markets and International Capital Flows: Britain, the Americas, and Australia 1865-1914. Cambridge: Cambridge University press, 2001.

Ferguson, Niall. The Ascent of Money. London: Penguin, 2008.

Fletcher, Ian. Free Trade Doesn’t Work: What Should Replace it and Why. Washington DC: US Business & Industry Council, 2010.

Hausmann, Ricardo, Jason Hwang and Dani Rodrik. “What You Export Matters.” Journal of Economic Growth (2007)

Imbs, Jean, and Romain Wacziarg. “Stages of Diversification.” American Economic Review (2003).

Ricardo, David. On the Principles of Political Economy and Taxation. London: John Murray, 1821.

Reinert, Eric. How Rich Countries got Rich and Why Poor Countries Stay Poor. New York: Carroll & Graf, 2007.

United Nations Conference on Trade and Development, “World Investment Report 2016: Annex Tables.” Accessed July 5, 2016.  http://unctad.org/en/Pages/DIAE/World%20Investment%20Report/Annex-Tables.aspx

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About Spencer P Morrison 45 Articles
JD candidate, writer, and independent intellectual with a focus on applied philosophy, empirical history, and practical economics.Author of "America Betrayed" and Editor-In-Chief of the National Economics Editorial.

10 Comments

  1. Beauty of an article. I was a big fan of Fletcher’s “Why free Trade Doesn’t Work”, which I see you sourced.

    The first point about Ricardo is not something I knew about. Pretty shocked tbh.

    • Yes, that was one of the better books on the topic. Also check out:

      Reinert, Eric. How Rich Countries got Rich and Why Poor Countries Stay Poor. New York: Carroll & Graf, 2007.

      Ricardo was a smart man (everyone’s heard of Adam Smith, no one’s heard of Ricardo—to me that’s one of the great mysteries), so I knew there was going to be some sort of limit to his theory. There’s always a limit, and if someone knows what they’re talking about, they will find it and try to correct for it before someone else points it out.

      That’s what Ricardo did. And frankly it was a decent band-aid until the advent of bulk transport and steamships. The world changed, the theory didn’t.

  2. The article, as well as the books written by Eric Reinert and Ian Fletcher refer to the erroneous notion of comparative advantage that is propagated by economic textbooks.

    In case you are interested in reading more about the differences between this erroneous notion of comparative advantage and Ricardo’s original numerical example, please search for the paper “Ricardo’s numerical example versus Ricardian trade model: A comparison of two distinct notions of comparative advantage”.

    • Thanks for the comment.

      I am familiar with the distinction, having read:

      https://www.researchgate.net/publication/48375755_Ricardo's_numerical_example_versus_Ricardian_trade_model_A_comparison_of_two_distinct_notions_of_comparative_advantage

      However, I (like the author of this paper, and Ricardo himself) acknowledge that comparative advantage is domain-specific. No level of mental gymnastics is ever going to fix this issue, because it’s intrinsic in the theory.

      The nuance of the distinction comes into play regarding the reallocation of labor after comparative advantage is maximized, however, as I stated in my point about the Okun gap, this is often mitigated by the reality that factors of production are often non-transferable.

      • Thanks for the reply.

        I’m always genuinely interested in learning new arguments in favour or against what has been called the “theory of comparative advantage”.

        What do you mean when you state that “comparative advantage is domain-specific”?

        • That’s great to hear, most people aren’t so curious. I’ll do my best and see if I can explain it:

          Domain specificity means that (theory) X only applies within certain parameters, or when condition A is met.

          For example, a Gaussian distribution (X), or bell curve, is domain-specific, because it only applies to normal data distributions (condition A), like heights of people. If the data isn’t normally distributed (condition A isn’t met) because the data is fat-tailed etc., then you can’t create a bell curve.

          Bell curves only apply to normally distributed data (a specific domain), not fat-tailed data (a different domain).

          Comparative advantage is likewise domain-specific, because it should only be applied to domestic trades (domain 1), not international trades (domain 2).

          • Thanks for the short and clear explanation.

            Regarding your claim that “Comparative advantage is likewise domain-specific, because it should only be applied to domestic trades (domain 1), not international trades (domain 2)”, that depends entirely on your definition of comparative advantage.

            As I have shown in this paper (http://hope.dukejournals.org/content/43/4/743.abstract), Ricardo wanted to illustrate with the famous numerical example two interrelated propositions:
            1. the non-appliance of the labour theory of value in international exchanges; and
            2. that a country might import a certain amount of a commodity although it can produce these commodities internally with less amount of labour time than the exporting country.

            Both propositions refer of course to international trade, remain as valid today as they were in 1817.

            • Good article, thanks for sharing it with me.

              Allow me to clarify, I’m afraid I may have lost some of the nuance in the interests of simplicity.

              Yes, I agree comparative advantage applies internationally, and it was meant to. However, the theory was predicated upon capital immobility. This would be the domain restriction I was referring to.

              If capital was mobile, then the theory doesn’t necessarily apply, & doesn’t work as it should, regardless.

              Industrial offshoring was an anticipated problem, and an admitted problem. Although by all means, if you think I’m off the mark, please let me know.

              Cheers.

  3. Once I initially commented I clicked the Notify me when new feedback are added checkbox and now each time a remark is added I get four emails with the same comment. Is there any way you possibly can remove me from that service? Thanks! bbfdceccbfgffcfb

  4. How would a single global currency and the elimination of all effective national boundaries affect trade suppositions? As this appears to be the end game of global human civilization, one might suggest either (a) a system of universal basic income or (b) WW III. Which, do you suppose, our global money masters might be able to control better, and with more predictable outcomes? Or is depopulation via option (b) the desired goal, as with previous internecine disputes between conglomerates of monied interest classes.

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